Crunch to Crisis

Corporate defaults trigger financial downturn

India’s resilient growth over the years has made it one of the fastest growing economies in the world. In the past year, in particular, the country has benefited from softening crude oil prices, benign retail inflation and growing consumption demand. However, recent corporate defaults have caused a perturbation the entire financial ecosystem. The collapse of once stable large companies such as Jet Airways, Reliance Communications (RCOM) and Infrastructure Leasing and Financial Services (IL&FS) have shocked the business world. The corporate debt crisis, which has led to stunted growth in corporate advances from the banking sector, was a manifestation of sectoral issues which have plagued the economy over the past five years. The recent capital infusion by the government in public sector banks (PSBs), which have the bulk of total sour loans on their books, will provide some relief under the prompt corrective action framework, thereby underpinning credit growth. However, a stricter stance towards delinquency, belt-tightening of rating agencies, among other measures, need to be taken to avert a series of corporate defaults snowballing into a crisis.

The Jet saga

The past financial year saw significant activity in the aviation sector with development of new greenfield airports. The latter part of the year also saw activity in terms of privatisation of Airports Authority of India-owned airports in Jaipur, Ahmedabad, Thiruvananthapuram, Mangaluru, Guwahati and Lucknow. The Adani Group emerged as the highest bidder for all six airports. As a result, the company became the third major private conglomerate in the country after the GMR Group and the GVK Group to enter the airport sector. Further, a consortium headed by the Tata Group took significant stake (45 per cent) in GMR Airports, thereby ensuring the Tata Group’s presence in the sector.

The attractiveness of the airport sector, however, was not mirrored by the airline industry where macroeconomic factors including high fuel prices contributed to airlines posting losses. Jitin Makkar, vice-president and head, credit policy, ICRA Limited, says, “The year 2018-19 was among the most challenging

years in recent periods. A bevy of challenges were borne by industry participants, some relating to macro and industry-wide factors, while others relating to firm-specific issues. A sharp uptick in jet fuel prices, particularly in the first half of the just concluded fiscal year, and depreciation of the rupee against the dollar harmed the profitability of airlines significantly. These apart, firm-specific factors such as failure of engines of a specific make and grounding of aircraft of a specific make not only curtailed growth prospects but also had an adverse impact on the profitability of the affected airline companies.”

Jet Airways, which was the single largest full service carrier in the country till 2017-18, ended up grounding 75 per cent of its fleet by the end of 2018-19. A stress resolution process is under way after the lenders have taken over the company and are on the lookout for interested bidders. When Jet Airways started operations in 1993, state-run Air India was the only formidable opponent, and the country’s aviation market was just taking off. Jet’s problems began when it embarked on an aggressive international expansion plan and faced stiff competition in the domestic market from low-cost carriers such as IndiGo. Despite the infusion of funds by Abu Dhabi-based Etihad Airways, the airline’s issues compounded with high fuel prices and hefty taxes. All this has saddled Jet Airways with a debt of over $1.2 billion, and the carrier suffered a total loss of about Rs 43 billion during 2018.

As part of Jet Airways’ bailout plan, the banks infused interim funding of Rs 15 billion into the airline to help revive operations and eventually ready it for sale. However, lenders released funds only in small amounts and the airline found it insufficient for running its operations. Therefore, it temporarily cancelled all domestic and international flights with immediate effect on April 17, 2019. Meanwhile, the lenders, who have bought 51 per cent in Jet Airways, have shortlisted four potential investors – Etihad Airways, the National Infrastructure and Investment Fund and private equity firms Indigo Partners and TPG.

The downfall of one of India’s most successful international brands illustrates the intrinsic challenges of the aviation sector, dominated by low-cost carriers such as IndiGo and SpiceJet. Cut-throat competition and attempts to capture larger market shares have forced airlines to compete, even at a loss, to continue expanding operations and increase market share.

Survival of the fittest telco?

The year 2018 saw the consolidation of the Indian telecommunications market into three large private players – Reliance Jio, Bharti Airtel and Vodafone Idea – accounting for over 90 per cent of revenue and 80 per cent of spectrum holding. The entrance of Reliance Jio along with the 4G technology had left the incumbents unprepared, leading to existing players needing to either consolidate or shut shop.

According to Makkar, “The telecom sector has been facing competition-induced disruption over the past few years and the previous fiscal year was yet another period of lower profitability and balance sheet strength of industry participants. While the industry has seen significant consolidation, credit quality pressures persisted throughout the year. The prominent old guards have stayed put and plan to strengthen their balance sheets through a mix of equity capital-raising and sale of tower assets.”

Well-established players such as Aircel, Tata Teleservices and RCOM have been forced to exit the telecom sector and the resolution process for lenders who had advanced funds to these companies is still under way. RCOM, which had catapulted to becoming the second largest telecom operator in the country in 2010, is on the brim of facing bankruptcy proceedings in the National Company Law Tribunal (NCLT). The beleaguered telecom firm failed to garner subscribers for its services and as a result was not able to grow in sync with the rest of the telecom industry. Apart from the entry of Reliance Jio, the growing debt burden without a commensurate increase in income was another challenge for RCOM. According to estimates, nearly half the company’s debt was towards buying spectrum. Its dismal financial health weighed heavily on the performance of its stock, which is currently trading at single digits on the bourses. Also, the proposed merger with Aircel did not materialise and the legal tussle between Ericsson and RCOM further added to the latter’s financial woes. Weighed down by Rs 460 billion debt, it was forced to scrap its wireless assets sale to Reliance Jio, following successive legal obstacles.

Shadow banking: The narrative of IL&FS

Makkar states, “At the beginning of 2018-19, the health of India’s banking system, particularly of PSBs, had appeared precarious, marred by asset quality and earning pressures, capital constraints, and governance-related challenges. However, during the course of the year, following capital infusion in PSBs by the government, credit quality pressures have eased. ICRA’s outlook on ratings of several PSBs has also been revised to stable from negative.”

Makkar continues, “For non-banking finance companies (NBFCs) and housing finance companies (HFCs), 2018-19 was a tale of two scenarios. While during the first half of the year the asset growth momentum, investor confidence and asset quality position followed the favourable trend lines of the earlier years, the second half was stressful for credit quality. In the second half of 2018-19, the credit quality of select NBFCs and HFCs was weighed down by an increase in the cost of funding, some asset quality pressures especially on the wholesale lending books, besides challenges relating to liquidity and asset-liability mismatch.”

On the tenth anniversary of the collapse of Lehman Brothers which triggered the global financial crisis in 2008, India had its own near-Lehman moment. The country’s infrastructure financing conglomerate, IL&FS started reneging on repayments one after the other. Reportedly, IL&FS piled up a debt obligation of Rs 910 billion. Of this, nearly Rs 600 billion was at the project level, including road, power and water projects.

As government-owned firms held more than 40 per cent shares of the company, the government stepped in to ensure financial stability in the country. It has replaced the IL&FS board with six selected nominees and a resolution plan has been drafted to resolve the crisis. As part of the debt resolution plan, the group’s companies have been categorised into green, amber and red, based on their financial position. The government has maintained the waterfall system during asset monetisation, wherein the seniority of lenders would be followed as is done under the Insolvency and Bankruptcy Code (IBC). The new management wants IL&FS to be maintained as a going concern. It has received binding bids for the energy business. Between the energy and road verticals, the company plans to recover Rs 300 billion of debt. A large number of road assets are also part of the sale process.

The recent IL&FS episode, the related lapse on the part of rating agencies, and the looming threat of a liquidity squeeze across the NBFC sector have raised concerns of a spillover, as exposure of banks and mutual funds to NBFCs has risen in recent years. The difficult market conditions induced by the IL&FS crisis and the rising costs of borrowing are likely to make survival of small and less capitalised NBFCs difficult. It is also likely to drive consolidation among the NBFCs in order to create stronger and diversified asset bases, to ensure diversification of risk, driving benefits of scale and operating leverage, and lower funding costs. This move is expected to gain further traction after the Power Finance Corporation’s recent acquisition of the Rural Electrification Corporation.

Next steps to avert a crisis

A spokesperson from a leading investment bank says, “The only way to resolve the issues is to address the systemic concerns impacting infrastructure sectors. The Reserve Bank of India (RBI), in the past three to four years, had come up with circulars (and later retracted) which could only offer a temporary solution at best. It is only the government that could come up with concrete steps to resolve sector-related problems. Now that some of the assets, particularly in the power, road and steel sectors, are with PSBs, the government can take over the ownership of these assets at a fair market value/asset value and operate them to ensure revenue generation.

However, such a dispensation cannot be extended to the telecom sector as the public sector undertakings, both Bharat Sanchar Nigam Limited and Mahanagar Telephone Nigam Limited, are struggling to keep their own heads above water. The case of the airline sector is similar – the state carrier is in enough trouble already and cannot be relied upon to take over stressed airlines such as Jet Airways. However, unlike the telecom sector where tariffs are low, air travellers are bearing the impact of high airfares. Despite this, the airlines are still under financial stress, indicating that the sector economics are unviable. Given the high level of competition in the industry, the government does not need to regulate airfares and should only enhance the quality of service by allowing unrestricted investment sources for airlines.”

In order to pare debt, companies are taking various measures for deleveraging their balance sheets. The asset-light strategy has been mostly resorted to by large companies so as to focus on core operations. The Tata Group’s investment in GMR’s airport vertical is one such instance. The infrastructure investment trust (InvIT) route is also gradually gaining in popularity among corporates to become asset-light. Recently, Reliance Jio transferred control of its fibre and tower arms to two InvITs – the Digital Fibre Infrastructure Trust and the Tower Infrastructure Trust – set up by a wholly owned unit of Reliance Industries. In a first-of-its-kind move in the country’s infrastructure sector, the Hindustan Construction Company (HCC) has created a pool of arbitration awards and claims and transferred its beneficial interest and rights to a special purpose vehicle controlled by BlackRock-led investors. The proceeds of

Rs 17.5 billion will be used by HCC for debt reduction. This route of monetisation of claims can also be explored by infrastructure players that are stuck at different stages of arbitration, to increase liquidity and service debt.

“The corporate debt crisis had snowballed into a financial sector crisis recently. Various policy measures have already been taken by the regulators for de-risking banks (by introduction of entity exposure and group exposure norms), alongside measures taken to deepen India’s corporate bond market. However, the efficacy of these measures would likely play out only over the medium term. Notwithstanding the recent Supreme Court verdict overturning the RBI circular of February 12, 2018, reforms such as the IBC are likely to have favourable consequences in terms of facilitating debt resolution and enhancing financial discipline of borrowers,” says Makkar.